The Latin American Trend ...
And Now, Who Is Ready for Transfer Pricing in Argentina

Horacio Peña and Leandro Passarella (PriceWaterhouseCoopers)

(EDITOR'S NOTE)

In December 1998, the Argentine Congress enacted a significant tax reform that, among other modifications, included new transfer pricing rules. This particular change represents a critical stride toward integrating the tax rules of Argentina with the international regime that has emerged among the developed countries as a consequence of the deliberations conducted by the Organization for Economic Cooperation and Development (OECD). The reform is an important step intended to provide Argentina with a tax regime that would complement and be consistent with the trade liberalization and outward-looking economic policies implemented since the beginning of the Menem Administration in 1989, which is finishing next December.

The changes made to articles 8, 14, and 15 and the addition of an article after article 15 of the Argentine Income Tax Law (AITL) were mainly driven by the government’s objective of increasing its tax revenues. According to some statements made by officials, it is believed that new tax revenues from transfer pricing audit and compliance would exceed $1.0 billion. In addition, Argentina’s major trading partners–except the most important one, Brazil–have similar rules to deal with the transfer pricing issue in intercompany transactions.

The principal changes embodied in the AITL as they pertain to intercompany pricing include:

4. New documentation requirements.

Prior to the enactment of the 1998 reform, the article 14 of the AITL already required Argentine subsidiaries of foreign companies (the "controlled companies") to enter into transactions with their controlling companies at arm’s length for Argentine income tax purposes. Otherwise, such transactions would have been treated as contributions to the capital of the Argentine subsidiaries by the foreign controlling companies and as dividends distributed by the former to the latter. Nonetheless, the prior text of the article 14 stated special rules for intercompany loans and intercompany transfers of technology, which were stated in the Foreign Investment Law and the Transfer of Technology Law, respectively.

The 1998 reform maintains the rule of the article 14 for controlled company transactions, although it has modified this article to repeal the old rules applicable to intercompany loans and transfers of technology. Likewise, the definition of comparability provided has been implicitly modified to be consistent with that already included in the OECD Guidelines. In principle, these rules apply to transactions entered into by foreign entities and their Argentine controlled companies. In this regard, an "Argentine controlled company" continues to be an entity incorporated in Argentina by a foreign entity that owns either at least 49 percent of the Argentine entity’s capital or has enough voting power to control its shareholder meetings.1 In addition, transactions between Argentine companies and entities incorporated in tax haven countries will be presumed not to have been entered into at arm’s length.

Finally, an important unresolved issue is whether transfer pricing adjustments for Argentine income tax purposes will affect the assessment of taxpayers’ value added tax and/or excise tax liabilities.2

The 1998 reform has modified a procedure applicable to all import and export transactions, which already existed in the AITL but were only applicable to related party transactions.3 The modification has made this procedure applicable even to import and export transactions entered into between unrelated parties. We call this procedure the "prevalent wholesale price procedure," because of its reliance on the wholesale price of the goods transacted to arrive to the acceptable price. According to this procedure, if in an import transaction the price of the foreign goods is higher than their prevalent wholesale price in Argentina or in the exporter’s market plus the cost of insurance and freight, the excess of the former over the latter will be characterized as Argentine-source income of the foreign exporter.

Likewise, if in an export transaction the price of the Argentine goods is lower than their wholesale price in Argentina or in the importer’s market plus the cost of insurance and freight, the excess of the latter over the former will be characterized as Argentine-source income of the Argentine exporter.

It appears that the prevalent wholesale price procedure was devised as a convenient way to deal with transfers of tangible goods for which there exists a well-established market and prices are readily available as it is the case with commodity products. In the absence of that market and those prices, the six transfer pricing methods would apply. This situation is very likely to occur in the case of related party transactions, where in many instances the transferred goods contain intangibles embedded (such as a trademark).4

It is important to note that for Argentine legal purposes, the term "goods" not only includes tangible goods but also intangible goods, such as rights.

Thus, it would be possible that a broad interpretation of the prevalent wholesale price procedure could lead to the conclusion that the procedure also applies to transfers of technology and other types of intangibles. This interpretation would not be consistent with the arm’s length standard since by definition every intangible is unique and cannot be treated in the same way as a commodity product.

The AITL, as modified by the 1998 reform, now provides for the use of profit-based transfer pricing methods. This is perhaps one of the most important changes in the AITL since Argentina now conforms to the OECD Guidelines, even though it is not one of its members. In this regard, although there is no distinction between the methods applicable to transfers of tangibles and transfers of intangibles, the AITL now follows all of the internationally accepted methods for evaluating whether controlled transactions, in particular, and cross-border transactions, in general, meet the arm’s length standard. The new six transfer pricing methods included in the AITL are:

6. The Transactional Net Margin Method ("TNMM").

Like the Mexican rules, Argentina has adopted the two versions of profit split methods described in the OECD Guidelines: The PSM and the RPSM, which allocate the combined operating profit or loss of a business activity according to the relative value of each party’s contribution to the combined profit or loss.

In addition, the AITL now provides that the "most appropriate method" will be used to determine whether a transaction meets the arm’s length standard.

Another critical reform to the AITL is the requirement to Argentine controlled companies to present "special tax reports containing detailed information including data and supporting evidence" that the controlled company transactions are entered at arm’s length. Although not directly referred to, this new rule is very likely to be interpreted by the Argentine tax authorities as a contemporaneous documentation requirement for all Argentine controlled companies. Once again, future regulations to be issued would specify the scope of this new requirement, determining the content of these special tax reports.5 However, it is clear from the reading of the law that future regulations in this regard will merely expand the current document requirement to more clearly state that controlled companies are required to produce and maintain documentation demonstrating that the income and deductions arising from all controlled company transactions are consistent with the amounts that would have resulted had these transactions taken place with uncontrolled companies operating under similar conditions.

In this regard, since the Argentine transfer pricing rules are very similar to the Mexican ones, it is most likely that the special tax reports that the Argentine controlled companies will have to file in the future could be inspired by or be similar to the Mexican documentation requirements. Should this be the case, such information would include:

4. A description of the method selected, an explanation of why that method was selected and a description of the comparables that were used, how comparability was evaluated, and what (if any) adjustments were made.

In addition, taxpayers would have to explain why the prevalent wholesale price procedure was rejected as a viable method.

The 1998 reform has not included the Advance Pricing Agreement procedure (APA) as a legal recourse for evaluating transfer prices and reducing controversies. The reason for this decision is that the Argentine Civil Code provides a general prohibition to the tax authorities to settle any cases involving public revenues.6

In addition to the new legislation, Argentina is also implementing important institutional changes in its tax administration. It first merged the General Tax Administration (Dirección General Impositiva or DGI) with the Federal Customs Administration (Administración Nacional de Aduanas or ANA) into the Federal Administration of Public Revenues (Administración Federal de Ingresos Públicos or AFIP) in 1996. Now, the AFIP has recruited a group of specialized professionals fully dedicated to transfer pricing. By law all government agents are entitled to conduct transfer pricing audits.

However, in an effort to increase quality control and reduce the likelihood of a large number of controversies, it is contemplated that (at least initially), only members of this group will conduct transfer pricing audits. In this regard, although the new transfer pricing rules included by the 1998 reform do not apply to related-party transactions entered into in prior years, this team has began to audit companies.

Although there are no special penalties applicable to transfer pricing adjustments, the normal penalties for understatement of income apply. Fines could range from 50 to 100 percent of the unpaid tax and, in the case of fraud, they could range from 200 to 1000 percent of the evaded tax. Penalties for tax fraud would not be applicable to transfer pricing cases, unless there is supporting evidence that there was intent to evade taxes explicitly.

The new transfer pricing rules included by the 1998 reform are effective since December 31, 1998. Consequently, they will apply to all cross-border transactions, in general, and controlled company transactions, in particular, entered into as from that date. So far, the AFIP has only issued partial transfer pricing regulations. Argentine taxpayers should review their results before the end of the companies’ fiscal year. Regarding the transfer pricing documentation requested by the new rules, it should in principle be in place by the filing date (i.e. approximately four months after the fiscal-year end).

A major issue to take into account is the difference between the Argentine and Brazilian transfer pricing rules. This difference would create significant risks of double taxation for multinational corporations engaging in business activities in both countries. Since the transaction volume between the two countries is very large, the 1998 reform in Argentina may serve for Brazil as an incentive to modify its current transfer pricing regime and to adopt new rules consistent with the arm’s length standard and the OECD Guidelines. Indeed, on October 9, 1999, Brazil enacted new rules that begin to move in that direction.

The 1998 reform and the institutional changes that have been taking place and are foreseen in Argentina in the immediate future represent a significant change that must be addressed by multinational corporations with Argentine subsidiaries. Compared to the rules of its major trading partner, Brazil, the basic transfer pricing regime enacted by the Argentine government is in general terms consistent with the OECD Guidelines and the U.S. regulations. The inconsistencies in rules between Argentina and Brazil could create significant risks of double taxation unless companies carefully plan and document their transactions. In the long run, the risk of double taxation will remain until Brazil embarks in a significant overhaul of its transfer pricing rules.

1. The partial regulations on transfer pricing issued provide that, for Argentine transfer pricing purposes, the control over an Argentine company would be determined not only by the ownership percentage but also by the leverage of the Argentine company or the functions that the foreign company would perform in the Argentine company that may influence the Argentine company’s activities. Regulations to the AITL, second article included after article 21.

2. The article 10 of the Argentine value added tax law provides that the market price of the goods or services transacted will be used as the base for the assessment of the VAT if the transfer price does not express such market price. The article 6 of the Argentine excise tax law contains a similar rule. It would be possible to conclude that transfer pricing adjustments for income tax purposes could affect value added tax and excise tax liabilities.

3. AITL, article 8.

4. See Regulations to the AITL, article 11.

5. The Argentine tax authorities have already drafted regulations that provide for the contemporaneous documentation requirements. Resolución (AFIP) No. 702. Its publication in the Argentine Federal Register is expected any time soon.

6. Civil Code, article 841(2).

Horacio Peña is a Partner and Senior Economist in the New York office of PricewaterhouseCoopers L.L.P. Mr. Peña is responsible for coordinating the firm’s Transfer Pricing Services in Latin America. Leandro Passarella is a member of the International Tax Services Group in the New York office of PricewaterhouseCoopers L.L.P.